Global Insight Perspective
CNOOC hopes that the investment will increase annual output to 350 million boe/y by 2020, which would turn the South China Sea into a major supply source of oil and gas, particularly for China's southern provinces.
CNOOC's announcement is indicative of China's push to develop offshore resources to offset stagnant or declining production at major fields such as Daqing. There are some concerns however over CNOOC's ability to reach the targets given its limited experience in deepwater drilling to date and current shortages of deepwater drilling rigs.
Lower margins due to oil prices of around US$50 per barrel and the domestic demand falloff are likely to undermine the pace of CNOOC's aggressive E & P programme in the short term while ongoing sovereignty issues in the South China Sea may limit the scale of future exploration initiatives.
CNNOC Announces South China Sea E&P Plans
China National Offshore Oil Corp. (CNOOC) and its partners will spend 200 billion yuan (US$29 billion) to develop hydrocarbons in the South China Sea between 2009 and 2020. According to Luo Donghong, chief development engineer at CNOOC's Shenzhen unit, 15 billion yuan (US$2.1 billion) will be spent on building deepwater drilling equipment and on research. Of this investment, 6 billion yuan (US$879 million) would be spent on building a 3,000-metre drilling vessel and 3 billion yuan (US$ 439.5 million) on a 2,500- to 3,000-metre pipeline installation vessel. CNOOC also announced that it would gradually expand deepwater exploration from 1,500 metres to 3,000 metres from 2009 to 2010, according to Luo. The company’s investment includes the contribution of partners as well as foreign affiliates such as Devon Energy Corp., Husky Energy Inc., Anadarko Petroleum Corp., and BG Group. The investment is expected to come from CNOOC's two Hong Kong-listed arms, CNOOC Ltd and China Oilfield Services Limited.
CNOOC's announcement marks a major push to develop China's offshore resources to offset depleting reserves in other areas of China and to meet future oil and gas demand. The South China Sea is around a third of the size of China, spans 3.5 million sq.km and currently has estimated geological reserves of 3.1 billion tonnes of oil and gas. It therefore holds significant potential as a new source of oil and gas production. China's government hopes that exploration and production (E & P) initiatives in the sea will discover long-term supplies of energy for China's southern provinces, particularly for industrial and manufacturing hubs like Guangdong. CNOOC hopes that reserves in deepwater areas of the South China Sea will grow to reach 22 billion boe by 2020 while overall annual output from the sea will increase to 350 mmboe by 2020 as a result of CNOOC's new investments. Given that China is forecast to consume around 8.2 million barrels of oil in 2009, CNOOC's announcement suggests that reserves in the South China Sea would have the potential to provide significant supplies to the domestic market as well as to increase China's energy supply security.
CNOOC also announced today that it hopes its annual deepwater production from the South China Sea will reach 1 million barrels per day by the next decade. CNOOC's plans are ambitious and there are some concerns over whether the company is able to realise the production targets given its limited experience in deepwater drilling, where to date, it has tended to team up with foreign partners. Today’s statement however is indicative of CNOOC's greater confidence in developing offshore resources, as indicated by its announcement in September that it planned to finance and develop 12 wells in the South China Sea without the assistance of foreign companies (see China: 26 September 2008: CNOOC to Develop Deepwater South China Sea Blocks Without Foreign Assistance). However, the global shortage of drilling rigs could undermine CNOOC's plans. In October Andarko Petroleum and Newfield Exploration Co. were forced to delay drilling programmes in the sea by between three and six months due to a shortage of rigs. CNOOC is also not expected to commission its own deepwater drilling rig until 2010 so the company's independent development of new reserves is likely to be limited over 2009. However, CNOOC may use the coming year to push forward with development of the Liwan field along with partner Husky Energy, given that the West Hercules semi-submersible rig owned by Norway's Seadrill has now been commissioned and is on its way to the field. With a significant 4 and 6 tcf of recoverable gas reserves at the field, ramping up production from Liwan is likely to be important if CNOOC is to realise its forecast production increases.
Outlook and Implications
Looking ahead, there are two main stumbling blocks for CNOOC in its quest to develop resources in the South China Sea. The first is the global financial crisis. While CNOOC posted 30.88 billion yuan (US$4.5 billion) in revenues for the third quarter of 2008, a 69% increase year-on-year (y/y), the fall in international oil prices from US$147 per barrel to current levels of US$50 will likely eat into CNOOC's margins, as will the falloff in domestic oil demand (see China: 29 October 2008: China's CNOOC Announces Q3 Revenue Increase of 69% Y/Y). While CNOOC has pledged to maintain its exploration budget for 2009, CNOOC chairman Fu Chengyu did warn last week that if the crisis were to deteriorate or even continue there could be an impact on the company's operations. Because of the financial crisis CNOOC has announced that it will move cautiously to develop deepwater projects in the sea, although this might prevent the company from meeting its production targets, given their ambitious nature. Moreover, the longer duration and higher capital costs of deepwater E & P projects mean that they are more vulnerable to being affected by financing problems. The company however, does enjoy significant state backing and has announced that it will be spreading its capital expenditure costs among its listed units and foreign affiliates, which may improve its chances of weathering future financial difficulties.Sovereignty issues and political tension over maritime border demarcation are the second potential obstacle to CNOOC's plans. Luo avoided stating precisely where in the sea CNOOC would be carrying out its exploration initiatives. Over the last year most exploration activity by CNOOC has occurred in the waters south of Hong Kong although to realise significant production increases CNOOC may be tempted to explore further afield, raising the possibility of inter-state tensions. In July China already warned ExxonMobil against pursuing a co-operation agreement with Petrovietnam for exploration in a disputed area of the sea, calling it a breach of sovereignty. The incident suggested however that littoral states are still willing to attempt to launch exploration activities in disputed waters. Indeed U.S. firm Crestone has in the past conducted exploration work for China in disputed waters claimed by Vietnam while Vietnam and the Philippines have also conducted exploration work in disputed waters. CNOOC may be prepared to repeat contentious exploration initiatives as part of its programme, raising the possibility of bilateral tensions between China and its neighbours and highlighting the increased urgency of moving forward with international maritime demarcation initiatives in the sea.